Shares of Coca-Cola (KO) hardly moved after the drink giant released its third-quarter results on Tuesday before the market open.
After a retreat from May's highs around $43 per share, shares are trading closer to my estimate of Coca-Cola's fair value. With no compelling upside or downside potential at these levels, I remain on the sidelines.
Coca-Cola generated third-quarter revenues of $12.03 billion, down 3% on the year before. Excluding adverse currency movements and the impact of structural changes, revenues were up by 4% on the year before.
As a result of the fall in revenues, operating income fell by 12% to $2.47 billion. Again, when excluding currency movements and structural changes, earnings rose by 8%. A total of $658 million in one-time other income boosted net earnings by 6% to $2.45 billion.
As a result of modest share repurchases, earnings per share rose by 8% to $0.54 per share. Adjusted earnings, which came in a penny lower, and were in line with consensus estimates. Chairman and CEO Muhtar Kent commented on the third quarter performance:
We delivered sound third quarter results in the confines of an going challenged macroeconomic environment driven by increasing volatility across emerging markets.
Looking Into The Results
Coca-Cola reported a 2.5% drop in revenues. This fall in revenues was accompanied by a roughly 50 basis point fall in gross margins to 60.2% of total revenues. Yet Coca-Cola made a lot of progress containing selling, general and administrative expenses, which fell by 85 basis points to 36.8% of total revenues.
Other operating charges rose to $341 million, offset by other income of $658 million, which eventually resulted in the modest boost in GAAP earnings.
North American revenues inched up a percent to $5.72 billion, as operating income fell by 3% to $803 million. Latin American revenues were unchanged at $1.23 billion, as operating earnings of $720 million on those revenues are unheard off.
European revenues rose by 10% to $1.42 billion, while the unit reported a 6% improvement in operating earnings. Disappointing were the revenue falls in Eurasia, the Pacific and the Bottling Investments, all the result of currency translations and divestitures of bottling operations.
Coca-Cola ended the third quarter with $20.5 billion in cash, equivalents and short-term investments. Total debt stands at $36.2 billion, for a net debt position of nearly $16 billion.
Revenues for the first nine months of the year came in at $35.8 billion, down 2% on the year before. On the back of strict general cost control, Coca-Cola limited the GAAP earnings fall by 4% to $6.9 billion.
At this pace annual revenues are expected to come in around $47 billion. Annual earnings could come in between $8.5 and $9 billion.
Trading around $37.50 per share, the market values Coca-Cola at around $166 billion. This values the company at around 3.5 times annual revenues and 18-19 times annual earnings.
Coca-Cola currently pays a quarterly dividend of $0.28 per share, for an annual dividend yield of 3.0%.
Some Historical Perspective
Over the past decade, shares of Coca-Cola have steadily risen from lows of $20 in 2004, to highs of $43 earlier this year, as shares were re-testing all-time highs set around the same level back in 1998. Shares have fallen some 12% from May's highs to current levels at $37.50 per share.
Between 2009 and 2012, Coca-Cola increased its annual revenues by a cumulative 55% to $48.0 billion. Cumulative earnings rose by 32% to $9.0 billion in the meantime. The company retired some 4% of its shares over the same time frame.
Coca-Cola reported little inspiring headline numbers, although adjusted for divestitures and currency fluctuations, the underlying results were quite solid. While volatility, both in terms of middle class purchasing power, economic growth, and currencies is distracting and resulting in short-term headwinds, the company remains upbeat about its prospects. Coca-Cola remains committed to execute on its goal to double "system revenues" between 2010 and 2020.
Emerging market headwinds are temporary, as the middle class continues to grow in the long term. Coca-Cola remains very pleased with its diversified portfolio, both in terms of drink categories and across geographic regions, allowing the firm to navigate through this challenging environment. Note that the firm served a total of 181 billion drinks over the past quarter, as worldwide servings rose by a solid 2%. Notably volatility in currencies, such as the Brazilian real and the Indian rupee had an adverse effect.
That being said, Coca-Cola sees continued growth prospects, and even more important, pricing power without scaring off consumers. At the same time Coca-Cola's global shares in non-alcoholic ready-to-drink continued to increase for the 25th quarter in a row.
Back in April, I last took a look at Coca-Cola's prospects after the company released its first-quarter results. I urged investors to take some profits as shares were approaching all-time highs. At the time, shares were trading at 20 times earnings, while hardly showing earnings growth as the dividend yield was about 2.6%.
At levels around $42 per share, I found the earnings multiple too high given the modest earnings growth and increased leverage on the balance sheet. Ever since, shares have seen a fair pullback, retreating about $5. I think these are more fair levels, trading at 18 times earnings while paying out a 3% dividend yield.
Fair is fair; I don't see compelling upside or downside at this level, therefore remaining on the sidelines.